Which one of the following is not a ‘fundamental accounting assumption’ in the preparation of financial statements ?

Correct — A, (a) Matching concept. The booklet sets 'not' in bold italic, and the phrase in single quotation marks — 'fundamental accounting assumption' — is a term of art with a fixed content.

Accounting Standard 1, Disclosure of Accounting Policies, names exactly THREE fundamental accounting assumptions underlying the preparation and presentation of financial statements:

GOING CONCERN — the enterprise is normally viewed as continuing in operation for the foreseeable future and as having neither the intention nor the necessity of liquidation or of curtailing materially the scale of its operations. CONSISTENCY — it is assumed that accounting policies are consistent from one period to another. ACCRUAL — revenues and costs are accrued, that is, recognised as they are earned or incurred and not as money is received or paid, and recorded in the financial statements of the periods to which they relate.

The standard adds the rule that gives the three their special status: these assumptions are not usually specifically stated because their acceptance and use are assumed, and DISCLOSURE IS NECESSARY IF THEY ARE NOT FOLLOWED. That is what makes them assumptions rather than policies — a reader is entitled to presume them unless told otherwise, whereas an ordinary accounting policy must be disclosed whether it is followed or not.

The matching concept is not on that list. It is a genuine and important accounting concept — expenses of a period are set against the revenues of that period, which is why depreciation is spread, closing stock is carried forward and provisions for doubtful debts are made — and it is closely related to accrual, which is doubtless why it is offered here. But relation is not identity. Accrual answers the question 'in which period does this item belong', for revenues and for costs alike; matching then pairs the costs of a period with its revenues to arrive at profit. AS 1 elevates the first to an assumption and leaves the second as a concept.

So options (b), (c) and (d) are the three assumptions in the standard's own words, and option (a) is the answer.

Why the others are wrong

• (b)Going concern — Going concern IS one of the three fundamental accounting assumptions and cannot answer a 'not' stem. AS 1 describes it as the assumption that the enterprise will continue in operation for the foreseeable future, with neither the intention nor the necessity of liquidation or of materially curtailing the scale of its operations. It is the assumption that most visibly shapes the balance sheet: fixed assets are carried at cost less depreciation rather than at what they would fetch in a forced sale, prepaid expenses and deferred revenue expenditure are carried forward as assets, and liabilities are classified by when they fall due rather than as immediately payable. Where the assumption fails, the accounts must be recast on a liquidation basis and the departure disclosed — which is exactly the disclosure rule that marks these three out.
• (c)Accrual — Accrual IS one of the three, and it is the one most easily confused with the answer. AS 1 defines it as recognising revenues and costs as they are earned or incurred and not as money is received or paid, and recording them in the financial statements of the periods to which they relate. It is the assumption behind every year-end adjustment: outstanding expenses, accrued income, prepaid expenses, income received in advance. Its relationship with the matching concept is one of sequence rather than sameness — accrual establishes the period to which an item belongs, and matching then sets the period's costs against its revenues. The Companies Act, 2013 reinforces accrual's status by requiring, in section 128(1), that books of account be kept on the accrual basis and according to the double entry system.
• (d)Consistency — Consistency IS one of the three. AS 1 states the assumption that accounting policies are consistent from one period to another, and its purpose is comparability: a reader cannot judge whether performance has improved if the method of measuring it changed in the meantime. It does not freeze policy forever — a change is permitted where it is required by statute, by an accounting standard, or where it would result in a more appropriate presentation — but a change and its effect must be disclosed. Note that consistency appears twice in the vocabulary of this subject, as a fundamental assumption in AS 1 and as one of the traditional accounting conventions, which is a reason candidates sometimes doubt it belongs here. It does.

AS 1, Disclosure of Accounting Policies, is the standard that organises the vocabulary of the subject, and it draws two lines. The first separates the three FUNDAMENTAL ACCOUNTING ASSUMPTIONS — going concern, consistency and accrual — from everything else. Their distinguishing feature is procedural: they need not be disclosed when followed, because their use is assumed, but a failure to follow any of them must be disclosed. The second line concerns ACCOUNTING POLICIES, which are the specific accounting principles and the methods of applying them adopted by an enterprise in preparing its financial statements — methods of depreciation, valuation of inventories, treatment of goodwill, translation of foreign currency, and so on. There is no single list of policies, because the choice depends on the circumstances of each enterprise, and all significant policies must be disclosed, normally in one place. Governing their selection are the three MAJOR CONSIDERATIONS the standard names: prudence, substance over form, and materiality. Around this framework sit the traditional accounting concepts — business entity, money measurement, accounting period, cost, dual aspect, realisation, matching, full disclosure — which describe how transactions enter the books. The examinable point is that AS 1 does not treat all of these as equals. Three are assumptions, three are considerations, and the rest are concepts and conventions.

Key facts

• AS 1, Disclosure of Accounting Policies, names three fundamental accounting assumptions: going concern, consistency and accrual.
• These assumptions are not usually stated because their acceptance and use are assumed; disclosure is necessary if they are NOT followed.
• Going concern — the enterprise will continue in operation for the foreseeable future, with neither the intention nor the necessity of liquidation or of materially curtailing operations.
• Consistency — accounting policies are consistent from one period to another; a change requires disclosure of the change and its effect.
• Accrual — revenues and costs are recognised as they are earned or incurred, not as money is received or paid, and recorded in the period to which they relate.
• The matching concept is an accounting concept, not one of the three assumptions; it sets the expenses of a period against its revenues.
• AS 1 names prudence, substance over form and materiality as the major considerations governing the selection and application of accounting policies.
• Section 128(1) of the Companies Act, 2013 requires books of account to be kept on the accrual basis and according to the double entry system.

Common traps

• Answering the positive question. Three of the four options are the assumptions themselves.
• Treating matching as a synonym for accrual. Accrual fixes the period; matching pairs a period's costs with its revenues.
• Adding conservatism or realisation to the list of assumptions. AS 1 has exactly three, and prudence is a consideration rather than an assumption.
• Doubting consistency because it is also spoken of as a convention. It is both, and AS 1 makes it an assumption.

• practice — not a real PYQ

  Under AS 1, a fundamental accounting assumption need not be disclosed when it is followed. Disclosure becomes necessary :

  • (a)Only if the auditor requires it
  • (b)If the assumption is not followed
  • (c)In every set of financial statements
  • (d)Only in the first year of operations

  Answer(b) If the assumption is not followed

• practice — not a real PYQ

  Which one of the following is a major consideration governing the selection and application of accounting policies under AS 1, rather than a fundamental accounting assumption ?

  • (a)Going concern
  • (b)Accrual
  • (c)Substance over form
  • (d)Consistency

  Answer(c) Substance over form